Incremental Demand From Chilly China Will Support Oil Prices

Front-month West Texas Intermediate crude oil futures are trading at $51.50 as I write this, as Friday's oil price rally on OPEC+production cuts proved to be short-lived in the face of further sell-offs in global equity markets. Fans of late 1980s hard rock will know 5150 as the name of the first Sammy Hagar-voiced Van Halen album and also know that 5150 was a sly reference to the section of the California Welfare and Institutions Code that grants authorities the power commit an individual on an involuntary psychiatric hold.

So, is oil at $51.50 a sign of that energy traders are crazy? No, but please do not make the mistake of thinking oil prices are an up-to-the minute reflection of the state of the global energy markets. No, oil futures trade based on sentiment, speculation and hedge fund exuberance much more than they do an actual fundamentals.

I wrote this in my Forbes column Friday and I will repeat it here: the global market for crude oil is closer to a state of true supply-demand balance than it has been at any time in this economic cycle, which is now nine years old.

A Chinese woman braces herself against gusts of chilly wind on the streets of Beijing. (AP Photo/Ng Han Guan)

Global demand and supply for crude oil are both running at a very round clip of 100 million barrels per day (mmbpd) by my estimates, which are similar to those published by the International Energy Administration. The key figure for any commodity of course is the second derivative, the change in direction, and I believe the next move for oil prices will be upward. For that to happen from a state of balance there must be a movie in marginal supply or demand. While supply from U.S. oil producers,the oft-misspelled group of "frackers" (fracing is spelled without a "k") and Saudi and Russia is covered ad nauseum by the financial media, there is very little focus on demand.

That's what the financial media is missing. I believe the demand for oil will accelerate in the next few months. Why? It's cold in Beijing.

Last week saw a nasty cold spell hit the Chinese capital, and temperatures remain below normal levels. I called the spike in U.S natural gas prices in my Forbes column earlier this winter by simply opening a window and observing cold temperatures. I am writing this column in Raleigh, North Carolina, where residents are attempting to dig out from 6 inches of snow and the associated wintry mix, which is even worse. So I am still bullish in U.S natural gas prices, but how does that impact China?

Cold is cold. That applies anywhere in the world.

The news that China's oil imports reached a record level in November received little fanfare on Friday in the wake of equity market turmoil. According to Platt’s the Middle Kingdom imported 42.87 million barrels of oil in November. That figure compares with China’s minuscule exports of 260,000 barrels of oil, so, yes, China imported 165 times more oil than it exported in November. That imbalance is especially acute in times of need, and that's where another figure in Platt's data is relevant.

China's fuel oil imports rose 40% in November to 1.5 million barrels. This is obviously a small part of the total amount of oil that is used in China. Globally, about two-thirds of every barrel of oil is used for transportation fuels, and that is very apparent on the streets of Beijing and Shanghai.

Again though, the key for oil pricing is the incremental barrel, and a cold winter in China is producing incremental demand for heating fuels. Ideally that heating fuel would come from natural gas, which in its pure methane form (CH4) is much cleaner than fuel oil. To be sure Chinese demand for natural gas is rising, as the country's imports of natural gas in its liquefied form (LNG) reportedly rose 34% in the first 11 months of 2018.

That shows the need for heating fuels in China, and with the government clearly attempting to avoid a repeat of last winter's heating oil shortages, fuel oil is the heating fuel of last resort.

So, temperatures in Beijing are more important to the intermediate-term pricing of hydrocarbons than the losses that loafer-clad hedgies are taking on their positions in oil futures on any given day. China will continue to represent the marginal demand for oil, and while the market obsesses over marginal supply you should initiate long positions in oil futures to play that dynamic.

I have researched stocks for 22 years, starting fresh out of college at Lehman Brothers and then moving to Donaldson, Lufkin and Jenrette. At DLJ I was a Senior Analyst following US auto parts companies before relocating to London to originate DLJ's European Automotive cove...